Some people think the terms saving and investing mean the same thing – but they dont. In truth, they represent two distinct ways of managing money. Understanding the difference may help you make informed choices for your financial needs.
Saving: A focus on Preservation
Generally, the real meaning of saving is seeking to preserve assets that you accumulate over time. For savers, stability of principal is a higher priority than return potential. A saver tends to be risk adverse and typically stores money in instruments such as savings and call accounts, which facilities are offered by banks and building societies. These types of low-risk vehicles ordinarily offer relatively low potential for return, but the principal and interest are guaranteed. While they may be suitable for your immediate and short-term liquidity needs, they are seldom the best choices for accomplishing your long-term financial objectives, due to their modest potential for returns.
Further, bear in mind that the modest return potential of many low-risk savings instruments might not even keep pace with inflation. As the cost of living increases, you will need more money to buy goods and services and meet your financial goals. Your money should have the potential to grow faster than inflation if you are to gain ground achieving your long-term financial objectives.
For example, suppose you want to purchase an item that currently costs $10 000, and you have $7500 set aside. If you put the $7500 in an account earning a hypothetical five percent average annual total return, youll have $12 216 in 10 years. However, if the items cost increases with a hypothetical annual inflation rate of five percent during the same period, it will cost $16 288 at the end of the 10-year period. In this example, you are $2500 behind your goal in todays terms. In 10 years, because of the effect of inflation, you will be $4072 behind. To help make your $7500 grow to $16 288, a decade from now, you would need an average annual total return of about 8.5 percent.
Investing: An emphasis on accumulation
When you invest your money, you are seeking growth. While investing usually involves greater risk to principal than saving, it may offer greater rewards, namely higher return potential. Most investments, such as shares, bonds and unit trusts, may fluctuate in value. African Alliance for instance, offers a wide range of unit trust products, which invest in the aforementioned financial instruments. Apart from individual investors, Pension and Provident funds also utilize such investment vehicles. Investors need to be willing to tolerate the ups and downs, and understand that they may lose principal if their investments decline in value. In exchange for the risk, investors get the possibility of greater income or growth (depending on the investment), and potentially better inflation protection than low-risk savings instruments might offer.
Strategies such as diversification can help manage the risks of investing. By spreading your money among different types of assets, such as equity, fixed-income investments and cash, you can strive for a comfortable balance of risk and return potential that will meet your needs.
Which approach is right for you?
Should you save or should you invest? Your answer may depend mainly on factors such as your financial goals, how much you have accumulated and how much you still need to adequately fund your goals, your time horizon and your feelings about risk.